Jim Cramer’s 7 Basic Rules of Investing

The stock market can be a rough ride for individual investors. Sometimes, entire sectors that are being endlessly hyped can suddenly tank — the dot.com bubble, for example. Other times, trading can appear to be dominated by a series of interlocking automated programs, creating scenarios such as the so-called “Flash Crash” of 2010.

Political forces can impact markets in seemingly unpredictable ways, such as the partial government shutdown causing a general depression on Wall Street or a change in Securities and Exchange Commission policy allowing or disallowing certain types of trades. To top it off, individuals like Bernie Madoff have become household names, representing the greed that can cause some to turn their investing operations into outright scams.

In the midst of all of these issues, how can the little guy survive, let alone make money? Jim Cramer, the host of CNBC’s Mad Money, answered the question by urging a return to some of the fundamentals of investing. He said some of the simplest rules are the most relevant. Cramer of course conceded that there are many risks inherent to investing — some of them not directly related to the stock market — but he added that there are also many ways to mitigate those problems.

Let’s take a look at seven of Cramer’s top tips for personal investors looking to stay alive in today’s markets.

7. Don’t Own Too Many Low-Dollar Stocks

Cramer urged investors not to get overly caught up in stocks that are worth less than $10. He offered two primary reasons for his advice: such stocks are valued so low because the markets don’t think that they’re worth very much, so they probably aren’t; and such stocks are often in the danger zone to drop to zero, meaning that they are investments in which someone can lose all of his or her money. Cramer advised keeping no more than one stock with a value of less than $10 in an investment portfolio, representing an amount of money that someone can afford to lose.

6. Own the Right Number of Different Stocks

For the next tip, Cramer reminded viewers that investors are just that: investors. Unlike mutual funds, which often need to own a high number of stocks, investors can get away with a lower number. Cramer put out 10 as his magic number for the count on how many stocks a private investor should be invested in at any given time. He said that this will give plenty of time to stay current on the news and happenings of the companies that you are invested in, all while making sure you have enough variance in stocks so that one company heading south won’t sink your entire portfolio.

5. Diversify

Cramer takes the idea of “back to basics” to a new level with his next tip: diversify. The age-old keyword of investing is never more important than in today’s markets, where entire sectors — not just companies — can decline fantastically in a matter of months. Cramer noted that diversification means not only variance in terms of companies and sectors but also variance in terms of geography, strategy, and strengths and weaknesses, all of which can serve to ensure that your portfolio doesn’t get wiped out based on isolated events in the markets.

4. Don’t Undervalue Dividends

Cramer highlighted a common mistake made by newer investors: They don’t value dividends highly enough. He said this is especially important during times when stock prices are going down, because that invariably means that dividend yields are going up. Dividends can serve as a great way to make money when the markets are sinking across the board, Cramer noted, which helps to explain his focus on dividends and dividend yields when choosing stocks that are good picks to own as the debacle in Washington keeps markets depressed.

3. Don’t Use Market Orders

For his next tip, Cramer advised investors never to use market orders. Instead, he advocated always using limit orders. In essence, what this means is that when you call your broker to place an order to buy or sell a stock, make sure that you include a price point with the instruction. That way, you’ll be prevented from selling a stock if it has suddenly lost value or from buying a stock if it has suddenly gained value. Cramer compared the exercise to sending someone to the supermarket to buy food. You wouldn’t just tell that person to buy something, you’d also tell him or her the most (or least) that you’re willing to spend.

2. Never Buy Stocks on Margin

Cramer warned of the dire consequences that can occur when people purchase stocks on margin, or by borrowing money and then investing it. Not only can this lead to massive debt if one incurs losses, but it also compounds the impact of small losses. Cramer pointed out that a great place to make use of leverage is in a mortgage, where someone can make a down payment and then build value over time, but that such schemes are out of place in the stock market.

1. Know What You Own

Source: http://www.flickr.com/photos/phild41/

The top spot on the list goes to an adaptation of the old adage “know thyself” — adjusted for the stock market, of course. Cramer is adamant that investors carefully track their positions in companies, adding that doing homework so you’re up to date with the happenings at a company is just as important as knowing the exact makeup of your portfolio. Cramer urged investors to spend about an hour per week keeping up with each company in your portfolio, saying that doing a little bit of research is the key to avoiding pitfalls such as the Facebook IPO and in detecting the unrealistic results coming from someone like Bernie Madoff.